Orora Increases Exposure To North America

Most brokers believe Orora has made the right decision to sell its Australasian fibre business to Nippon Paper, although this increases its exposure to North America.

-Could private equity take a look or further asset sales ensue?
-Canned beverage business is growing versus glass
-Capital return expected upon completion of transaction

By Eva Brocklehurst

Packaging business Orora ((ORA)) has found the right buyer and the right price for its Australasian fibre business, assessing the offer is at a premium to comparable transactions and in the best interests of shareholders.

The sale to Nippon Paper for $1.72bn exits a mature business and removes a lower-margin/return operation from the portfolio. The deal also reduces the company's footprint in Australasia to beverage packaging, which accounted for around $170m in earnings in FY19.

Citi considers this move strategically and financially positive, with the low likelihood of another offer probably why management considered Nippon Paper made a compelling proposition. Brokers await the company's AGM on October 14 for further details on the outlook for the remaining business.

The sale of the business means private equity, and others, could be taking a look at Orora's remaining assets, Credit Suisse asserts. The company will be left with a higher-quality beverage operation, which principally operates in glass and cans.

These are two areas where private equity could scrape a pre-tax free cash yield of 6%, which the broker calculates is "not bad" given Australian bonds are at sub-1% levels.

The broker assesses the stock in the light of this potential, and upgrades to Outperform from Neutral. Nevertheless,earnings estimates are reduced, with Credit Suisse suspecting weakness on the back of a soft US manufacturing survey and questioning whether the company's statement that "initiatives were being implemented to deliver earnings growth" means that earnings are not growing.

The operating environment is making it difficult to integrate the Pollock and Bronco acquisitions, in the broker's opinion. That said, Credit Suisse acknowledges management does not want to break up the company and will not run an asset sale program, although investors may price further asset sales into the stock.

The Australasian beverage business is growing as the company's major beer customer, Carlton United Brewery, has been migrating customers to cans from glass. There is also growth in non-alcoholic canned beverages.

Citi believes the company will be well-placed to benefit from potential substrate switching to metal cans or glass from plastic. Glass is constrained by capacity and Australian wine export growth is flat, although Credit Suisse notes a cost reduction program should provide growth into FY21. Moreover, the broker ascertains the company's rival would need to put in substantial new capacity to win over any of its glass customers.

Capital Return

The company intends to return $1.2bn to shareholders through the most efficient capital management initiatives. The transaction, netting $1.55bn, is expected to complete early in 2020, following customary conditions such as regulatory approvals, with returns envisaged likely in the first half of FY21.

Ord Minnett assumes the transaction closes in January 2020 and $1.2bn is returned to shareholders via special dividend while UBS considers the most likely option is a combination of a special dividend and share buyback

The company has also signalled an intention to maintain an investment grade credit rating with a leverage ratio of between 2.0x and 2.5x.

North America

Morgan Stanley believes the sale provide significant scope for capital management but also increases the exposure to North American earnings risk. Assuming the transaction is completed, North America would make up 40% of the company's earnings (EBIT) an increase from 32% in FY19, the broker calculates.

North America remains of concern as earnings margins fell -90 basis points in the FY19 results, to 4.5%. Morgan Stanley expects margins to remain subdued at around 4.6% in FY20 before increasing to 5.0% in FY21.

Ord Minnett takes a similar view, notinging the quality of the portfolio has been diluted by the fact North American business now represents close to half of group earnings. Hence, the broker's rating is downgraded to Hold from Accumulate. Ord Minnett assumes the transaction closes in January 2020 and $1.2bn is returned to shareholders via special dividend.

FNArena's database has two Buy ratings and four Hold. The consensus target is $3.15, suggesting 3.5% upside to the last share price. Targets range from $2.97 (Morgans, yet to comment on the transaction) to $3.40 (Credit Suisse).

Disclaimer: The writer has shares in the company.

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